Seadrill Ltd. (SDRL) announced its fourth quarter 2012 and preliminary full year 2012 results on Thursday, February 28. At first glance, the results look especially good, particularly since the company expected that downtime would be a problem. Indeed, downtime was a problem but the overall impact on the company's results was not particularly terrible. However, before beginning an analysis of the company's latest quarter, let's have a look at the highlights from Seadrill's report:
- The company's EBITDA for the quarter came in at $604 million. This is an increase of $30 million over the previous quarter.
- The company's net income was $50 million or $0.04 per share. This is a large decrease from the third quarter's net income. Seadrill had a net income of $216 million or $0.40 per share in the third quarter.
- Seadrill's contract backlog increased by $2.3 billion during the quarter.
- Seadrill raised $207 million from the NYSE listing of Seadrill Partners (SDLP).
- Seadrill increased its ownership stake in Asia Offshore Drilling to 66.16%.
As is immediately obvious, Seadrill saw an enormous decline in its net income quarter over quarter. However, this is not a sign of a problem. The primary reason for this decline is that Seadrill had to take an impairment charge of $221 million due to its ownership stake in Archer during the quarter. This was partially offset by a $17 million gain on forwards and cross currency interest rate swaps but it still had a significant effect on the company's results. However, this was a non-cash write down. Seadrill did not actually spend any money here nor did any cash leave the company or become available to shareholders. With that said, however, Seadrill did see its operating cash flow drop to $241 million from the $413 million that the company brought in during the third quarter.
Seadrill has historically operated with negative free cash flow as the company spent heavily to build up its rig fleet. That changed for the better in 2012 as some of the new rigs, such as the West Leo, came online and began working. In 2012, Seadrill had total operating cash flow of $1.59 billion. The company had total capital expenditures of $1.557 billion, nearly all of which was spent to further grow the company's fleet. This gives Seadrill a positive free cash flow of $33 million for the year. While this is still insufficient to cover the costs of dividend payments and interest on the debt, it still represents an improvement over the negative free cash flow that the company has had in past years. Seadrill will likely see its free cash flow improve further over the next few years as its new rigs come online, although the upcoming sale of its tender rig division will have a negative effect on free cash flow and may be enough to push free cash flow back into the red until the new rigs that come online in 2013 and 2014 begin operating.
Seadrill reiterated its previous statements about the strength of the offshore drilling industry. Seadrill's management extended these statements to include the long-term horizon and, if management is correct, these market fundamentals could prove to be very good for Seadrill and its shareholders (these market fundamentals will be discussed more in depth later in this article). The reason why these fundamentals could be good for the company is because of its newbuild program. Seadrill currently has six ultra-deepwater floaters under construction that have not yet been contracted out. As the dayrates for these rigs are generally in the low $600s ($600,000 to $625,000), these six rigs clearly offer significant revenue potential assuming that Seadrill success in contracting them out at these rates. Readers of my other articles on this topic already know that Seadrill is unlikely to have any difficulty accomplishing this due to the current industry dynamics. These rigs will also make a substantial contribution to Seadrill's goal of achieving $4 billion of annual EBITDA by 2015. This is due to the profitability of these rigs. An ultra-deepwater rig costs approximately $180,000 per day to operate. Thus, at a dayrate of $600,000, an ultra-deepwater rig can be expected to contribute approximately $400,000 to EBITDA per day of operation. Seadrill has six of these rigs under construction that have not yet been put under contract plus an additional three new rigs that have been put under contract so the potential here for earnings growth is clearly quite large.
Seadrill also has the opportunity to improve its results further through improvements in its operating performance. This appears to be something that the company is firmly committed to doing. As I discussed in a previous article (linked above), Seadrill's downtime results in the fourth quarter were nothing short of terrible. Seadrill's floater fleet (semisubmersibles and drillships) achieved an economic utilization rate of 86% in the quarter. While this is better than the 82% that the company achieved in the third quarter, Seadrill did see its rigs suffer from significantly more downtime. In a press release dated January 31, Seadrill stated that it expected downtime in the fourth quarter to be approximately 100 days for the company's floater fleet. Seadrill did not provide a more accurate figure in its report but if we assume that 100 days of downtime is accurate then it still represents a worse performance than the ninety days of downtime that Seadrill experienced in the third quarter. Seadrill's management stated that the company's goal is to achieve utilization rates from its floater fleet of 95% or better so the Board is quite disappointed with this quarter's performance. Indeed, until the most recent quarters, Seadrill was consistently achieving utilization rates in excess of 90% which makes this goal look achievable if Seadrill can solve the problems that it has been having with the blowout preventers on its rigs which is the chief cause of these downtime problems. If Seadrill succeeds in its aforementioned utilization goal then it will also result in a boost to revenues as a higher utilization rate means that more rigs are spending more time operating and thus earning revenue.
Seadrill does not appear likely to achieve this goal in the first quarter however, as the company has already suffered downtime worse than it did in the fourth quarter. The company has so far experienced 117 days of downtime on its floater rigs in the first quarter due to a need to replace the bolts on the blowout preventers on several rigs. This is an action that was mandated by the Bureau of Safety and Environmental Enforcement that required the replacement of all Vetco H4 connector bolts. This downtime will be a drag on the company's first quarter earnings, particularly so since it is the floater fleet that is affected, but this downtime should prove to be a one-off event and, since Seadrill has now corrected this problem, should not result in any further downtime. Seadrill will see even more downtime in the first quarter due to 21 days of planned downtime that is still to occur due to maintenance activities. This will therefore be the worst quarter for downtime that Seadrill has had in recent memory and possibly the worst quarter in the company's history.
As previously mentioned, Seadrill is very optimistic about the future of the offshore drilling industry. The company states that the supply of ultra-deepwater floaters in the North Sea and Norway is extremely tight through 2015. Not only that, but the whole area has a shortage of rigs with no available units until 2014. Oil companies operating in this area are still demanding rigs for future projects however, due to the need to replace resource production from older, maturing fields. Additionally, the company notes that development drilling is increasing as well which puts further pressure on the availability of ultra-deepwater rigs going forward. According to petroleum consultants at Rystaad Energy, the industry will require the construction of five hundred new ultra-deepwater rigs to be able to meet the needs of oil companies. Considering that only 107 new rigs have been constructed since 2005, the current tight financing market, and the insufficient capacity of shipyards to construct these rigs, it is unlikely that 500 rigs can be constructed to meet this demand. This will result in oil companies bidding against each other for the rigs that they need and this will drive up dayrates for rigs.
Seadrill also states that the jackup market is strengthening and cites recent contract trends as evidence of this. The three trends that are currently occurring that are indicative of a strengthening market are:
- Increasing dayrate
- Increasing contract duration
- Increasing contracting lead times
Seadrill states that all three of these have been seen in the jackup market over the past twelve months. The company also emphasizes that oil companies strongly prefer, or even require, modern high-specification rigs due to the complexity of modern wells. Oil companies also desire the increased performance, efficiency, and safety characteristics of newer rigs compared to older ones. Seadrill is moving to take advantage of this strengthening market through the construction of new jackup rigs. Seadrill currently has twelve jackup rigs under construction including the three rigs being constructed by Asia Offshore Drilling, in which Seadrill owns a 66.16% stake. These new rigs should result in Seadrill capturing some of this market strength and grow the company's top and bottom lines.
Seadrill appears to be well-positioned for growth as the company's newbuilds come online into a strong market. While the sale of the tender rig division will reduce cash flow, management expects that the new rigs coming online will more than make up for this and expects to see operating cash flow growth in the first three quarters of the year. The strong market for offshore drilling rigs will also act as a tailwind and push up cash flows due to rising dayrates. All in all, it looks like a good time to be a Seadrill shareholder.